Production costs and pricing strategies of major producers

This section briefly examines the production costs of the three major producers for praziquantel (Bayer, E. Merck, and Shin Poong), to help explain the competitive positions and pricing strategies of these firms.

Bayer

Praziquantel was first produced and marketed in Germany by Bayer, and then rapidly moved to other parts of the world, including developing countries. The prices set by Bayer in the late 1970s and early 1980s took into account the market potential, the expense in developing the product, the realization that the patent would expire in the early 1990s, and the expectation that competitors would establish their own production capacity (Interview No. 2).

In the late 1980s and early 1990s, Bayer confronted competitive challenges in the international market, because Bayer’s cost and pricing structures are much higher than those of its competitors. Bayer officials explained the cost differential using the same factors cited by officials at E. Merck. For example, Bayer uses a “full costing” approach for all of its products, and no exceptions are made even for special, life-saving drugs developed for economically disadvantaged clients. Bayer officials also mentioned the uncertainties of the demand by governmental and other international institutions for the product, especially the problems of forecasting demand in a market with tenders, and the lumpiness with which contracts are awarded and won.

In addition, Bayer’s overall drug development strategy has moved away from tropical diseases, making it difficult to justify the opportunity costs of disrupting the production line to shift to praziquantel, and making it difficult to justify a price based on less than full costs (Interview No. 2).

According to company officials, Bayer has had several discussions with WHO to make praziquantel available, where needed, at a reasonable price, but those discussions have not reached a successful conclusion. Bayer representatives reported that some WHO officials were trying to persuade Bayer to provide the drug as a donation for all cases of schistosomiasis worldwide (Interview No. 2). However, according to company representatives, this donation is not likely to occur, since it would require perhaps 256 tons of the raw materials annually (based on WHO’s assessment of global need for praziquantel tablets). According to Bayer estimates, even at the best production cost at E. Merck of US$ 170 per kg, this amount would require 256 x US$ 170 x 1000, or US$ 43.5 million annually. At the normal Bayer price of US$ 450 per kg, the figure would increase to US$ 115.2 million per year. This figure, according to Bayer officials, represents a request for a donation of a multiple of the annual expenditures of Merck & Company (USA) to donate ivermectin (Mectizan), and still does not solve the issues of where the tablets would be manufactured or how the drug would be distributed. Bayer representatives also suggested that, given the financing capacities of developing countries and international agencies, the market could sustain a maximal production of about 100-150 tons of praziquantel.

Recently, Bayer has embarked on a new agreement for public-private cooperation related to praziquantel. According to a Bayer official, “Bayer, under a revised philosophy of addressing the needs of endemic countries, started talks with UN agencies regarding a new type of public-private cooperation. This will include, besides the supply of the drug at a price comparable to the major competitors, the definition of a bundle of additional services which could be rendered by a research-based pharmaceutical company to those countries and organizations pursuing schistosomiasis control programmes in the context of their national drug policy” (Interview No. 9). It is not yet certain what this effort will yield, or how other competitors will respond, should this initiative be implemented.

Bayer’s pricing strategy in the developed world is to have a common price at the consumer level in all countries, to the extent possible (Interview No. 2). Different prices of Bayer’s products at the wholesale level will often reflect different margins at the pharmacist’s level. Other price differentials stem from different inflation rates and VAT rates, so that a product which is available for US$ 100 in Germany can cost US$ 10 in Portugal. Distributors sometimes take advantage of these price differences between countries, so that an Italian distributor might purchase Bayer products in Spain, for an additional profit. Bayer Italy, however, cannot do so, according to company policy, which also constrains Bayer’s attempts to compete successfully in the world market.

E. Merck

The prices for E. Merck’s praziquantel products tend to be much higher than those of its competitors, due to two factors: production process and cost structure (Interview No. 3).

According to E. Merck representatives, Shin Poong uses a different process, with one less production step, which makes the process inherently cheaper. Production costs are also affected by the number of products. At E. Merck, praziquantel is only one of many product lines, and praziquantel does not have top manufacturing priority. Every time praziquantel is to be manufactured, the production line (the chemical vats and equipment) must be cleaned and prepared. A company (such as Shin Poong) that manufactures relatively fewer compounds, one of which is praziquantel, has fewer opportunity costs, and may be able to manufacture one compound almost continuously on one production line. E. Merck representatives suggested that if production could be expanded, then some savings could also be realized by the company (Interview No. 3). But the company currently has no plans to expand production, because of the cost and price disadvantages of E. Merck in the world market (see Chapter 5), catching the company in a vicious circle.

E. Merck’s policy on costing structure also places the company at a significant competitive disadvantage. The company sets the price based on full historical costs, so as to recover the original investment in research, development, and manufacture of the drug. Companies (such as Shin Poong) with a smaller initial investment, with a more efficient process, and with fewer other products on the production line, have a definitive cost structure advantage in pricing the drug. This price advantage is particularly important in bulk purchasing markets, where purchasing decisions are made primarily on price.

E. Merck seeks to maximize its profits through price discrimination in different market segments, as described above. E. Merck’s price structure (from highest to lowest prices) is as follows: private markets (pharmacy purchase or the equivalent), veterinary markets, insurance markets (in Germany a “reference” or “Festpreis” price), generics market, and bulk sales to non-governmental agencies or developing country governments.

E. Merck company officials suggested that the development of drugs for developing country markets has usually been considered a significant risk, because of inadequate patent protection (Interview No. 3). If a product attains wide acceptability, other manufacturers start to produce it and thus reduce expected profits for the original developer. E. Merck has seen this cycle not only with praziquantel, but also with other drugs (e.g., certain cancer drugs which were produced by firms in India and the Republic of Korea). It is not clear whether the new patent regime established by the Uruguay trade round of the GATT, with increased product patent protection, will change the perceived risks of drug development for tropical diseases.

E. Merck representatives also suggested that government or non-profit programmes that supply drugs free of charge have an adverse impact on the firm’s private markets. A policy of free drugs at the consumer level can contribute to irrational drug use and can make it difficult to charge full costs for the drug in the private market.

Shin Poong

Shin Poong has competed very successfully in the global praziquantel market since its entry in 1983. Shin Poong has benefited from much lower development costs (a total of only about US$ 14,000 to develop the alternative production process), and from the lower costs of its manufacturing process for praziquantel (see Chapter 3). These two factors have enabled Shin Poong to market its product at much lower prices in the Republic of Korea and in the international market.

Shin Poong’s entry into the international market in the mid-1980s caused Bayer and E. Merck to drop their sales prices significantly in almost every market where they competed with the Korean company. Despite their lowered prices, however, Bayer and E. Merck have been unable to regain their position as the leading producers of praziquantel, and, indeed, in the 1990s they have lost further ground around the world. By the mid-1990s, Shin Poong had established itself as the world’s largest producer of praziquantel and was expanding into new markets and new production opportunities, while Bayer and E. Merck were retreating (see Chapter 5). In short, Shin Poong’s strategy succeeded for the firm and also resulted in making praziquantel more readily available and affordable for poor consumers in poor countries.

Conclusions

Several significant lessons emerge from this chapter’s analysis of the global price trends of praziquantel and the production costs for different producers:

• Prices for praziquantel, at a single point in time, vary greatly across market segments, with the highest prices generally found in the developed country private markets and the lowest prices in the tender market for developing country governments and other institutions. This pricing strategy of market segmentation was found for all the major producers, and reflects broader patterns in the pharmaceutical industry.

• Over time, the prices of praziquantel in several market segments have declined significantly, ranging from 50% in some markets to a decline of 90% of the initial price over a decade-except for developed country markets (such as Germany) where prices for brand-name products have increased over time. The substantial price declines reflect the heightened competition from Shin Poong in the Republic of Korea and in other markets (after 1985) and from generic manufacturers (following patent expiry from 1991 on).

• Price data about praziquantel (and other products for tropical diseases) are not readily available, although the International Drug Price Indicator (Management Sciences for Health) provides an important compendium of some prices. Better price information on praziquantel (and other products) could improve the efficiency of government procurement efforts and tenders and could improve the functioning of the market for tropical disease products.

• The pricing strategies of Bayer and E. Merck are the result of higher production costs (associated with their manufacturing process for praziquantel, but also due to the relatively low priority of praziquantel in overall corporate strategy and the opportunity costs of praziquantel production). In addition, corporate policies of seeking to recover full historical costs have shaped the pricing strategies of Bayer and E. Merck.

• Shin Poong, on the other hand, had relatively low historical costs of R&D to recover for praziquantel, had fewer competing products, had discovered a less costly production process, and gave higher priority to production of praziquantel, all of which facilitated an aggressive pricing strategy both in the Republic of Korea and in foreign markets. Shin Poong took advantage of these factors to compete on price with Bayer and E. Merck in the late 1980s in those markets that did not recognize product patents (such as Egypt and the Republic of Korea) and to wait until the early 1990s for the original product patents to expire to compete in other markets.